RPC Must Read September 30, 2011

The Problems with Dodd-Frank

Real World Consequences of Ill-Conceived Legislation

H.R. 4173, the Dodd-Frank Wall Street Reform and Consumer Protection Act became law on July 21, 2010.  At almost 2,400 pages, it is more than twice the length of three previous regulatory bills – the Securities Act of 1933, the Securities Exchange Act of 1934 and Sarbanes-Oxley – combined.  The Congressional Budget Office estimates that it will cost $2.9 billion over the next 5 years to implement, and some claim there could be over $2 trillion in broader economic costs resulting from the Act.  The Dodd-Frank Act also creates more than 2,600 new positions at regulatory agencies, with some agencies, such as the Office of Financial Research, lacking any size limitations on their budgets or staffs.  Furthermore, the Act is creating regulatory uncertainty – with the almost 400 required rulemakings overwhelming the regulatory agencies as well as the private sector.

As each day passes and another regulation is finalized, the public is becoming aware of the consequences of the Dodd-Frank Act.  Specifically –

Higher costs to consumers: With higher regulatory costs, financial institutions are increasing fees to compensate for reduced revenue.  According to a recent survey conducted by Bankrate.com, many large financial institutions have eliminated their free checking accounts, and increased their fees.  The survey reports that just 45 percent of non-interest checking accounts are free, down from 65 percent last year and from a peak of 76 percent just two years ago.  Bankrate.com also noted big increases in monthly service fees and compensating balances required to avoid them.  On interest accounts, the average monthly fee is $14.05, up 8.5 percent from last year.  The balances required to avoid the fees rose 43.9 percent to $5,587.

The Durbin Amendment directed the Federal Reserve to cap the fee that banks can charge retailers when customers swipe their debit cards.  Taking affect October 1, 2011, the fee will fall from an average 44 cents to a maximum of 21 cents –and banks contend it will cost them billions of dollars and thousands of jobs in a fragile economy. 

• Bank of America disclosed in its most recent quarterly report that the Durbin Amendment will reduce the bank's debit card revenues by $475 million in just the fourth quarter of this year.  Consequently, the nation's largest bank announced that it will cut 30,000 jobs between now and 2014, slash $5 billion in annual expenses from its consumer businesses, and will begin next year to charge customers a $5 monthly debit card fee. 

• International Bancshares Corporation (IBC) of Laredo, TX announced that it will close 55 branches located in grocery stores, eliminating 500 jobs, as a result of reduced interchange revenue from the passage of the Durbin Amendment.  IBC uses interchange revenue to cover the cost of providing free checking and other products, and opted to reduce operating expenses (branch and payroll costs) instead, in an effort to preserve free offerings.
   

Fewer mortgages and larger down payments: With the Dodd-Frank Act, negative press, and pressure to buy back soured home loans, some financial institutions are becoming increasingly inclined to pull out of the mortgage business.  One of the few rules directed at the mortgage industry, credit risk retention, will require banks and other firms that issue mortgage-backed securities to keep a five percent piece of the loans that they bundle and sell as securities. 

A Qualified Residential Mortgage will not be subject to the new risk retention rules, but in order to obtain this new “gold standard” and the lowest interest rate mortgage, home buyers will have to produce at least a 20 percent down payment for non-FHA mortgages and have stellar credit.  The National Association of Realtors’ estimates that it would take an average family 12 years to scrape together a 20 percent down payment, creating another barrier to homeownership.

Fewer community banks: "Dodd-Frank has raised the cost of financial transactions in America and that encourages consolidation because it's the only way you can spread the costs over larger assets," said Tom Hoenig, president of the Federal Reserve Bank of Kansas City.  Community banks, largely responsible institutions throughout the financial crisis, will be placed under new pressures to survive.  Over 5,000 pages of new rules are expected from the Consumer Financial Protection Bureau (CFPB) alone, taxing the resources of smaller, community-based institutions. 

“We are expecting compliance costs to increase dramatically,” Oswald Poels, president and chief executive officer Wisconsin Bankers Association said. “This will force all banks to have a dedicated compliance officer, or officers, in order to stay on top of the changing regulations.  There is no question it will add to the cost of running a bank.”  The American Bankers Association predicts the Dodd-Frank Act will help drive more than 1,000 banks out of business.

Economic Costs:  During this period of economic uncertainty, considerable resources are being diverted to implement and comply with the Dodd-Frank Act.  A report prepared by the Financial Services Committee, One Year Later:  The Consequences of the Dodd-Frank Act, cites Government Accountability Office (GAO) estimates that by the end of FY 2012, the budgetary cost for the Act will exceed $1.25 billion, resources which could have been tasked toward deficit reduction.  Furthermore, the GAO forecasts that the Dodd-Frank Act will siphon from the economy over $27 billion in fees and assessments over the next ten years.   To comply with the new rules and regulations, banks and other financial institutions will have to spend thousands of man-hours on compliance, leaving them less time to focus on growing their business and the economy.  A survey of the Federal Register in the report shows that compliance will entail an estimated 2,260,631 labor hours each year.  Community-based banks will have to spend a larger portion of their budgets on compliance, rather than lending to businesses and consumers. 

The Dodd-Frank Act also imposes procyclical provisions that make the bad times worse and the good times better.  Huge increases in deposit insurance, increased capital requirements, restrictions on the types of capital allowed, and the Volcker Rule limiting proprietary trading, will prevent capital from being used to make loans and create jobs.   Additionally, when the Basel III international liquidity standards are implemented, they could also have an enormous impact on the economy.  Basel III is a new global regulatory standard on bank capital adequacy and liquidity, which will require banks to hold a minimum level of bank capital.  It is expected that capital requirements will increase from the current six percent up to a level between seven and 12 percent. Additionally, the Financial Services Committee report notes the Office of Comptroller of the Currency estimates that proposed margin rules on derivatives trades may require U.S. banks to sideline $2 trillion in collateral.  All this is at a time when the U.S. economy is still trying to find its footing and faces 9.1 percent unemployment.

Having just passed the one-year anniversary of the Dodd-Frank Act, it has become apparent that it failed to address the key culprits in the financial crisis – the roles of Fannie Mae and Freddie Mac and “too big to fail”.  Instead, the Dodd-Frank Act created the CFPB to bury banks under new regulations, caused the end of free checking accounts and debit cards, created the real possibility of 20 percent down payment mortgages, and is responsible for layoffs in the financial services industry.